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Excerpts from Liquidity & You

Chapter 1 (Excerpt)

Key Takeaways:


  • Proactive tax planning, implemented before a liquidity event occurs, can significantly reduce your tax bill—potentially saving you millions of dollars.

  • Don’t leave money on the table by underestimating your value or by agreeing to a deal that doesn’t maximize your wealth.

  • Protect your post-liquidity wealth. Two-thirds of successful business owners have been involved in unjust personal lawsuits and/or divorce proceedings.


As an entrepreneur, you have lots of peers. Currently, there are over 28 million businesses in the United States[1]—the highest number on record.


But as a highly successful entrepreneur preparing for a liquidity event, you are in much more exclusive company. Many of your colleagues—even successful, hardworking ones—never reach that golden destination of having a successful exit and realizing tremendous financial value for themselves and their families. Before you move further toward that goal, take a moment to reflect on your accomplishments to date and congratulate yourself on the impressive results of your efforts.


Now is also the time to take stock of the key financial challenges you must address as you approach a liquidity event. As is true for many entrepreneurs, the company you built (or run) is the single biggest asset on your personal balance sheet. That means you have a number of issues to consider before, during and after the sale of your business. More than likely, the vast majority of your time and energy has been spent working on the day-to-day operations of your business. You probably haven’t had the opportunity or inclination to think carefully about your exit strategy.


If you take the time now to formulate the right strategies, you will find that the liquidity event process can be a smooth ride. With the right advanced planning, you will be able to maximize your personal wealth—and do so on your own terms. By identifying the key financial challenges you face and by approaching them strategically, you will put yourself in the best possible position to accomplish three important objectives:


1. Maximize the wealth you receive through a liquidity event or exit.

2. Preserve that wealth for generations, if desired.

3. Achieve both the success and peace of mind that you envision for yourself, your family and your community.


If you don’t take the time to get your financial house in order, you can quickly find yourself eroding the value of your personal balance sheet that you have worked so hard to build—and potentially suffering from a range of negative financial and emotional outcomes. With that in mind, this chapter examines five key financial considerations to address as you near a liquidity event.


Liquidity Events: An Overview


First, the following is an overview of the various types of liquidity events and exit strategies that successful entrepreneurs tend to take:


1. Initial public offering (IPO).

2. Sale to a private third party (private equity firm, private competitor).

3. Internal sale to one or more partners, the existing management team or employee(s).

4. Acquisition by a public company.

5. Partial sale (aka “taking a bite of the apple”)—selling a partial stake to achieve liquidity while still being involved in the business and retaining some ownership.


It is important to note that each of these options, when employed properly, can help you achieve your liquidity goals and can give you the financial freedom to transition successfully to the next stage of your life. The key is to identify and use the option that is best suited for you and your situation. The good news: There are numerous resources available to help you do that analysis. For example, we introduce entrepreneurs to helpful experts with whom we have longstanding relationships, such as investment bankers, business brokers, M&A attorneys, private equity firms and venture capitalists, and even a financial therapist to help you navigate the psychological components.


The five key financial challenges


Based on my years of experience helping successful entrepreneurs, as well as my research and interviews with experts in the area of successful business exits, I have identified five key financial challenges that entrepreneurs who are about to “cash out” must address. The idea is to ensure that you make a smooth and successful transition from where you are today to where you want to be post-exit.


1. Minimizing income taxes on the transaction. It’s vital to determine the likely tax exposure that a liquidity event will trigger for you. You’ll also want to avoid any unpleasant tax surprises and mitigate that tax bill as much as possible.


Proactive tax planning that is implemented before your transaction can significantly reduce your tax bill. By how much? Consider that without a plan, you can pay more than 50 percent of your earnings in taxes here in California.[2] If you take a few basic steps, you can reduce that tax burden to around 37 percent. And if you make all the right moves in advance of the transaction, your tax bill can fall below 30 percent. Many entrepreneurs miss the “QSSB” rule that could potentially eliminate 100 percent of the taxes paid. Advanced planning can result in millions of dollars in taxes saved.


Despite the significant impact that tax planning can have on their net worth, entrepreneurs too often fail to plan around taxes effectively or don’t plan effectively enough. This should be at the top of your mind as you move toward liquidity. Perhaps most important, the discussions you have about tax planning need to be with professionals who deeply understand the situations and unique issues that you face as an entrepreneur. There are more than 77,000 pages in the U.S. tax code, and the rules and regulations pertaining to liquidity events are among the most complex on the books.


To have a successful liquidity event, you’ll probably need to go beyond a standard planning session with an accountant. You’ll want to engage with a specialized CPA firm, plus a law firm that works with entrepreneurs that are approaching liquidity events, as well as other specialists such as derivative and valuation experts. With expert strategies, you’ll find smarter ways to maximize your wealth and ensure ideal outcomes for yourself and your family. For example, if you have stock options, you can take steps to “get the clock ticking” on those options as early as possible. That way, gains from the sale can be treated as long-term capital gains instead of as short-term gains, thus potentially cutting your tax bill in half.



2. Maximizing wealth by not “leaving money on the table.” To get where you are today, you have had to make many smart decisions along the way. Your expertise about your business and your entire industry may be unmatched by anyone else. However, a liquidity event is a different beast entirely. There are numerous ways that you can unwillingly leave money on the table.


Say, for example, that you are a business owner selling your company to a private equity firm. Your job—your life—is to be great at your business. But the job of the MBAs sitting across the table from you is to acquire companies at an attractive price. Most likely they simply know the world of acquisitions better than you do. Your business might be selling software; their business is buying businesses.


This imbalance can leave you feeling uncertain, or even fearful that you are not getting a deal that maximizes your value creation. At best, without proper planning, you’ll leave some money on the table. In extreme cases, transactions can fall apart entirely because the deal terms include risks that the business owners don’t fully appreciate.


During my research, I interviewed many entrepreneurs who had successful exits from the businesses they ran. One of the questions I always ask is “What is your biggest regret?” Surprisingly (or not), some say exiting their business was their biggest regret. Others say their biggest mistake was agreeing to a cap on the earn-out. By underestimating their own value, they ended up leaving a lot of money on the table.


I’ve discussed failure with entrepreneurs. In one case, a private equity firm came in with an attractive offer for the founder’s company. One of the terms was that the private equity firm would infuse capital in the short term, ramp up the company’s staff and incur additional overhead to lay the groundwork for expansion. However, neither the founder nor the private equity firm anticipated the dramatic shift in the economy that occurred in 2008. The severe recession caused the deal to fall apart and the business ultimately folded, largely because of the ill-timed expansion plans.

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